National Income Accounting and the Current Account Surplus and Deficits J.D. Han, King’s University College 12-1

Review of Intermediate Macroeconomics National income accounts  measures of National Income (Y): Income  measures of value of Aggregate Output  Pi Qi) : Supply  measures of value of Aggregate Expenditure(AE): Demand: AE = C + I + G + EX - IM  Disposal of National Income : Y = T + C + S Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley. 12-2

Ex-post, Supply = Demand P = E = Y Records the value of national income that results from production and expenditure.  Producers earn income from buyers who spend money on goods and services.  The amount of expenditure by buyers (E)= the amount of income for sellers (Y)= the value of production(P).  National income is often defined to be the income earned by a nation’s factors of production. Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley. 12-3

Y=  Pi Qi = Supply Side NI: GNP  Y: What are factors of production? workers (labor), physical capital (like factories and equipment), natural resources and other factors that are used to produce goods and services.   Pi Qi: The value of final goods and services produced by labor, capital and natural resources, which belong to the Canadian nationals, are counted as Canadian GNP.  National Income and the total value of aggregate products are always equal to each other at ll times. Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley. 12-4

AE = Demand Side NI: GNE GNE is calculated by adding the value of expenditure on final goods and services produced. There are 4 types of expenditure: 1. Consumption: expenditure by domestic residents 2. Investment: expenditure by firms on plants & equipment 3. Government purchases: expenditure by governments on goods and services 4. Exports = expenditures by foreigners on domestic goods and services 5. AE= C d + I d + G d + EX Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley. 12-5

Y = P at all times: Supply Side E: Demand Side At equilibrium, Supply = Demand Y (= P )= E at equilibrium Y= C d + I d + G d + EX Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley. 12-6

However, for statistical convenience, consumption, investment, and government expenditures are all inclusive of expenditures on domestic and foreign goods. - Noone is always checking and classifying where the product he spends on is made! C = C d + C f; I = I d + I f; G = G d + G f Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley. 12-7

Y = C d + I d + G d + EX = (C-C f ) + (I-I f ) + (G-G f ) + EX = C + I + G + EX – (C f + I f +G f ) = C + I + G + EX – IM = C + I + G + CA surplus Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley Expenditure By domestic residents Net expenditure by foreigners

Now Incorporating Y = C + I + G + X- M and Y = C + S + T There are 2 ways of doing so: (1)Method 1 C+ I + G + EX – IM = C + S + T EX – IM = S – I + T - G Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley. 12-9

Method 2: From Y = C + I + G + EX - IM EX- IM (current account surplus) = Y – (C + I + G ) Trick is to put +T and –T so that Y = C+S+T is incorporated. = (Y – C – T) + (T – G) – I = S Private + S Government - I = S N – I * Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley. d 12-10

*Savings (1) S Private : the saving of the private sector or the households. Y = C + S Private + T S Private =Y – C - T (2) S Government: It is equal to government budget surplus. * S Government = T – G (3) National Savings S N = S P + S G Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley

If National Savings> Investment, then CA + If National Savings< Investment, then CA - Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley

* CA deficits are in fact Savings or Investment (supplemented) by Foreigners for this country I = S N – CA surplus = S N + CA deficits I = S National + S Foreign Countries can finance investment either by national savings or by acquiring foreign funds equal to the current account deficit, which is in fact savings by foreigners (non-residents) for this economy. When national S < I, then CA < 0, financial capital inflows for the domestic economy. A current account deficit implies a financial capital inflow or negative net foreign investment(= positive net investment by foreigners = net negative foreign investment by Canadians. Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley

* In the short-run, S p does not change very much, but S g does: Government Deficits are the major determinant of Current Account CA = S p + S g – I = S p – government deficit – I Government deficit is negative government saving  equal to G – T A high government deficit causes a negative current account balance, all other things equal. Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley

Relationship Between Government Deficits and Current Account Illustrated Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley Source: Congressional Budget Office, US Department of Commerce

**We can derive the same equation in an alternative way: Equilibrium National Income Condition was S private + T + IM = I + G + EX IM – EX = Current Account Deficits = = I – S private + ( G – T) = I – S Private + S Government = I – S National Modified by J.D. Han based on Materials provided by Pearson Addison-Wesley